Analysis and criticism of America's most prominent public intellectual and champion of Keynesian economics. I am part of the Austrian School of Economics, and I critique Krugman's writings from that perspective.

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Monday, May 31, 2010

Because Paul Krugman is the most visible spokesman for the Keynesian economic viewpoint (or, at least what Robert Higgs calls "vulgar Keynesianism"), I tend to deal with his statements from the New York Times, as it is convenient to do so, and Krugman clearly does a good job of stating his viewpoints from there. (I tend to avoid statements by James Galbraith, which are like Krugman's, although Galbraith does not do as well in squeezing the concepts into small spaces.)

One prominent economist who also understands the modern Keynesian orthodoxy is Higgs, who edits the Independent Review and who has been an eloquent voice against what Krugman and others promoting. Today, I examine a couple of articles that Higgs wrote in which he clearly lays out why it is that Krugman's orthodoxy is destructive.

The root problem, I believe, lies in the aggregative character of contemporary thinking about macroeconomic fluctuations. In this view, rising aggregate real output is good, no matter what the composition of the newly produced goods and services. A recession, which most analysts understand as a sustained decline of aggregate real output, is bad, and, in their view, it should be combated by fiscal "stimulus" and by expansionary monetary policy in order to reverse the decline in aggregate demand. They do not worry about – indeed, they rarely even pay much attention to – the makeup of the aggregate output that is added during business expansions, lost during business recessions, or brought into being by the government's compensating fiscal and monetary actions. Output is output; spending is spending. In fact, the whole idea of using government spending to offset reduced spending by investors or consumers turns on this assumption that a dollar spent is a dollar spent, regardless of what it is spent for.

However, that thinking, writes Higgs, is wrong because of its insistence upon the homogeneity of investment and output:

In today's vulgar Keynesian environment, investors and economists do not appreciate how the seeds of macroeconomic busts are sowed by artificially created credit that is employed to finance investments that would not be undertaken if they had to be financed by real savings – investments known in economic theory as malinvestments. When a large volume of malinvestments has been undertaken during a boom (e.g., much of the investment in residential housing and commercial real-estate development between 2002 and 2006), and when for whatever reason the pace of new credit creation slows, causing interest rates to rise, then the unsustainability of these malinvestments becomes increasingly apparent. More and more of them are terminated, often in unfinished condition, and many such projects go bankrupt for want of buyers willing and able to pay for them in the market. (Emphasis Higgs')

A "recovery" created by such means is no recovery at all, as Higgs explains:

If the government and the central bank use their fiscal and monetary policies to prop up these malinvestments, they do not solve the basic problem; they only paper it over for the time being. The vast assistance given recently to financial institutions embarrassed by investments in bad real-estate-related securities, for example, has allowed these institutions to delay the write-offs and other balance-sheet adjustments that would reflect the errors they have made. The bailouts have created a large number of zombie financial institutions, much like the ones that caused the Japanese economy to stagnate during the 1990s and later. Owners and managers of financial firms laden with rotten securities have been holding out for government rescues of various sorts, rather than carrying out the required restructuring, which in many cases must include bankruptcy proceedings.

Just as the malinvestments were made possible in the first place by effusions of artificially created credit and hence artificially depressed interest rates, so now the Treasury and the Fed are keeping the owners of these malinvestments afloat by further effusions of artificially created credit. But so long as these inherently unsustainable projects continue, they constitute a huge legion of the living dead. They may look viable, but their viability hinges entirely on de facto subsidies via the government's various bailout schemes. Such projects will remain unsustainable unless continually propped up at the expense of the general public, who will suffer because of increased ordinary taxes or a mounting inflation tax on their dollar-denominated assets. If the government goes forward in this fashion, it will be sustaining an economy rife with malinvestments kept in operation only by constant transfusions of other people's wealth channeled to the zombie projects by the Treasury and the Fed – a permanent policy of robbing prudent, responsible Peter to pay imprudent, irresponsible Paul. No sound, long-run economic development can be based on such productivity-sapping transfers of wealth into projects that are not worth the expense of keeping them going and which misallocate resources to the overall economy's detriment so long as they continue.

In this article, published in March, 2009, Higgs goes into more detail explaining why the aggregation of economic activity into the Y = C + I + G + (X-M) equation is just plain wrong and ultimately destructive. Writes Higgs:

This way of compressing diverse, economy-wide transactions into single variables has the effect of suppressing recognition of the complex relationships and differences within each of the aggregates. Thus, in this framework, the effect of adding a million dollars of investment spending for teddy-bear inventories is the same as the effect of adding a million dollars of investment spending for digging a new copper mine. Likewise, the effect of adding a million dollars of consumption spending for movie tickets is the same as the effect of adding a million dollars of consumption spending for gasoline. Likewise, the effect of adding a million dollars of government spending for children’s inoculations against polio is the same as the effect of adding a million dollars of government spending for 7.62 mm ammunition. It does not take much thought to conceive of ways in which suppression of the differences within each of the aggregates might cause our thinking about the economy to go seriously awry.

In fact, “the economy” does not produce an undifferentiated mass we call “output.” Instead, the millions of producers who bring forth “aggregate supply” provide an almost infinite variety of specific goods and services that differ in countless ways. Moreover, an immense amount of what goes on in a market economy consists of dealings among producers who supply no “final” goods and services at all, but instead supply raw materials, components, intermediate products, and services to one another. Because these producers are connected in an intricate pattern of relations, which must assume certain proportions if the entire arrangement is to work effectively, critical consequences turn on what in particular gets produced, when, where, and how.

These extraordinarily complex micro-relationships are what we are really referring to when we speak of “the economy.” It is definitely not a single, simple process for producing a uniform, aggregate glop. Moreover, when we speak of “economic action,” we are referring to the choices that millions of diverse participants make in selecting one course of action and setting aside a possible alternative. Without choice, constrained by scarcity, no true economic action takes place. Thus, vulgar Keynesianism, which purports to be an economic model or at least a coherent framework of economic analysis, actually excludes the very possibility of genuine economic action, substituting for it a simple, mechanical conception, the intellectual equivalent of a baby toy.

Compare this to what Krugman claims: that all that is needed for the government to "create prosperity" is for the central banks to print money and the government to borrow and spend. Yet, the profession claims that Krugman is the better economist? Somehow, I doubt it.

Friday, May 28, 2010

So, from calling for a return to the super-high tax rates of yesteryear to demanding that governments borrow and print money into oblivion, Paul Krugman believes that socialism really is the road to prosperity. In his post today, "Martin Wolf Is Not A Serious Person," he quotes Wolf and then declares that Wolf is correct.

I have now lost faith in the view that giving the markets what we think they may want in future – even though they show little sign of insisting on it now – should be the ruling idea in policy.

Actually, the Wolf quote is at the end of a long rant in which he excoriates the Organization for Economic Co-operation and Development because its members are rightly concerned about the spate of borrowing and ultra-loose monetary policies. Wolf, instead, believes that governments are not being profligate enough. He writes:

...fiscal tightening would only work if it coincided with a robust private recovery. Otherwise, it would drive the economy into deeper recession. Yes, that is a Keynesian argument. But this is a Keynesian situation.

Neither Wolfe nor Krugman explain why there is no "robust" recovery, however. The Keynesian explanation is that a market economy cannot generate by itself the necessary "spending" to move out of the doldrums. Only government can do that.

However, neither Wolfe nor Krugman can explain why that is so when, in fact, every recession before the Great Depression ended without a massive explosion of government spending, including the deep but short-lived recession of 1921. Why is this situation any different?

The problem is that neither person wishes to deal with the fact that the economy is full of malinvestments that governments still are trying to keep propped up, just as Japan tried to do the same during the "Lost Decade." To Keynesians like Wolfe and Krugman, all economic assets are homogeneous, and there is no difference between the activities of the state or private business, economically speaking, except that whatever the state does is morally and economically superior!

Krugman continues to claim that he is not a socialist, but if he wants the state to be doing everything, including confiscating huge amounts of income from individuals, then I don't see where his view differs from standard socialism.

Thursday, May 27, 2010

In his post, "Reasons to Despair," Paul Krugman declares that the prospects for economic recovery are "grim." I happen to agree with him, but our reasons are quite the opposite. For Krugman, his despair is based upon his belief that governments are not inflating enough, while I believe governments are inflating way too much. Obviously, there is no way for our ideas to intersect.

Krugman writes:

Here’s where we are: growing GDP, but mass unemployment still the law of the land, with only tiny progress so far. What can be done?

Well, we could have more fiscal stimulus — but Congress is balking even at the idea of extending aid for the ever-growing ranks of the long-term unemployed. Fiscal responsibility, you see — hey, and let’s make sure estate taxes stay low!

We could get tough with China, which continues its currency manipulation and, in the face of a world of grossly inadequate demand, is actually tightening monetary policy to avoid an overheating economy — when basic textbook economics says that it should be appreciating its currency instead, which would not only rebalance China’s economy but help the rest of the world. So given China’s outrageous behavior, Geithner went to China, got nothing .. and pronounced himself very pleased.

We could do more through monetary policy. Macro theory suggests that the theoretically right answer, if you can do it, is to get central banks to commit to a higher inflation target. But the Fed and the Bank of Japan say no, because … well, that’s not what central bankers do.

It’s depressing: shibboleths and conventional wisdom are blocking all routes out of this slump. And I worry that policy makers will just sit there, for years and years, all the while congratulating themselves on the soundness of their policies.

So, Krugman despairs because the governments won't print enough money and won't confiscate enough wealth from others. Now, he does not explain how destruction of the currency and confiscation of wealth will lead to a "recovery," but I am sure that the answers can be found in his columns.

And China is being "outrageous"? As a commenter pointed out, if China is trying to tighten its output of currency, that alone will result in "appreciation" of its money. (What Krugman claims is that China is overvaluing the US Dollar in relationship to its own currency, which actually makes its own people poorer, yet Krugman actually wants us to believe that this is good for China and bad for us.)

There is a larger problem here, and that is the Krugman-Keynesian view of the economy. In Krugman's view, consumption is irrelevant and unrelated to production. Instead of being purposeful, consumption is little more than "buying back the products made," as though the real purpose of consumption is to get goods off the shelves. In Keynesian doctrine, the purpose of an economy is production for its own sake.

Perhaps this is why Keynesians really wanted us to believe that the economies of the Soviet Union and the old Eastern Bloc were "growing" because the GDP numbers that their bureaucracies spit out were becoming larger every year. The Keynesians were fascinated with the "output" figures, but never once took a hard look at what was being produced, from autos to consumer goods, with much of it being outright junk.

So now, all that is needed is yet another "stimulus" outburst, higher taxes, and even more inflation, and that is going to bring prosperity? And, to launch what effectively would be a protectionist trade war with China? Right.

Should readers wish to get a more sound view of economics, read Henry Hazlitt's classic Economics in One Lesson. Although the first edition came out before Krugman even was born, nonetheless it really is a line-by-line refutation of the nonsense that the 2008 Nobel winner in economics puts out.

Wednesday, May 26, 2010

One of the standard Krugman-Keynesian beliefs is that assets are homogeneous, and that the only thing that matters in an economy is spending. (This is separate from real-live purposeful consumption, which is the end of all productive activity.)

In this line of thinking, a "liquidity trap" view of things makes perfect sense, and Krugman is fond of claiming that the U.S. economy, like Japan 20 years ago, suffers from such a condition. In his post on inflation and Japan, he repeats the old canard that deflation is the enemy and that inflation means nothing, at least at the present time.

(I find it interesting that in yesterday's post, he claims that "inflation did have to be brought down," although he does not specify what that was so, given that at the time, the nation's rate of unemployment was unacceptably high. There is no real consistency here, except to throw out partisan political barbs of "Democrats good, Republicans bad," which is acceptable at DNC headquarters, but I do not think is such when coming from a supposed Nobel Prize winner in economics.)

According to Krugman-Keynesian doctrine, an economy is in a "liquidity trap" if interest rates have a lower bound of zero or near-zero, yet businesses are not borrowing at a rate necessary to keep the economy going at the boom rates. That is why Krugman is fond of repeating his contention that current government borrowing only is replacing lost business borrowing, as though all borrowing has its use ONLY in the money spent.

When the economy is in such a "liquidity trap," according to Keynesians, then the only thing that can "stimulate" an economy is more government spending. That is because, according to Keynesians, there is no mechanism within a market economy that will allow economic activity to be generated, as though it were a dead battery that needs to be "jump-started" from the outside.

In a recent post on the Freeman Online, I take issue with the Keynesian approach, pointing out that the real issue we face -- as did Japan two decades ago -- is that government intervention has generated massive amounts of malinvestment. Our current situation is not a "liquidity trap," but rather is one in which the government has kept the malinvestments alive through the intervention via the Federal Reserve System.

For example, the huge amounts of resources poured into propping up the banks and other financial houses, along with keeping General Motors and Chrysler alive, drain the economy of productive capacity. Furthermore, the Obama administration clearly has shown itself to be hostile to real productivity and profitability, labeling profitable firms as being the cause of our problems and calling for higher taxes and other measures to cut the healthy firms down to the level of the unhealthy ones.

The real problem that Japan faced was that its economy had generated malinvestments during its previous boom, and those malinvestments needed to be liquidated, not propped up. Instead, the government tried to keep everything afloat and the result was the "lost decade." Likewise, we are seeing the same thing here.

Krugman, as a True Believer, does not see that. Instead, he really seems to hold that all assets are homogeneous, profits are a drain on the economy, and high taxes and the iron hand of the state will guide us to prosperity. This will not be the case, but I doubt seriously that he will change his tune, given the public worship that intellectuals and the political classes have bestowed upon him.

Tuesday, May 25, 2010

On November 21, 2004, I attended a session at the annual meeting of the Southern Economic Association in New Orleans, and the session speaker was...Paul Krugman. I sat with Prof. Joseph Salerno of Pace University, and we heard Krugman give his usual Keynesian address.

During the Q&A, I asked Krugman that since he was critical of cutting tax rages, then would he favor going back to the 70 percent top rates that existed before they were cut in 1981. Krugman's answer: "No! Those rates were insane!" (His term)

I am reminded of that answer in reading his blog post today about the "postwar system." (Krugman conveniently leaves out the collapse of the Bretton Woods accords in 1971, but since he considers money just something to be printed, I guess he would have considered that to be a good thing.) He writes:

Here’s what I think: inflation did have to be brought down — and Paul Volcker, not Reagan, did what was necessary. But the rest — slashing taxes on the rich, breaking the unions, letting inflation erode the minimum wage — wasn’t necessary at all. We could have gone on with a more progressive tax system, a stronger labor movement, and so on. (emphasis mine)

So, Paul, what is it? And if Krugman really wants me to believe that the standard of living for Americans was higher in the 1970s than it was in the past decade, well, I would like to sell him some ocean-front real estate -- in Nevada.

Monday, May 24, 2010

In reading anything by Paul Krugman, I always am prepared for him to distort the comments of someone he does not like to a point where it is obvious that either the man cannot read, or he cannot tell the truth. The primary victory of Rand Paul in Kentucky last week has put the Left into an out-and-out frenzy, and, not surprisingly, Krugman is trying to lead the pack.

Last week Rand Paul, the Tea Party darling who is now the Republican nominee for senator from Kentucky, declared that the president’s criticism of BP over the disastrous oil spill in the gulf is “un-American,” that “sometimes accidents happen.” The mood on the right may be populist, but it’s a kind of populism that’s remarkably sympathetic to big corporations.

Very interesting, and it seems that Democratic National Committee Chair Tim Kaine said something very similar about Paul's comments. (Hmmm, there is not any collusion between Krugman, the NYT editorial writers, and the DNC, is there? Oh, surely not. They claim to operate independently of one another.)

Now it’s the chairman of the Democratic National Committee, Tim Kaine, who “does a Maddow” and flat-out lies on national television about Rand Paul. On Fox News Sunday Kaine claimed that Paul said it was “un-American to hold BP accountable” for the oil spill in the Gulf of Mexico. Host Chris Wallace called him out by pointing out that what Paul said was “un-American” was a Democratic pol’s grandstanding bloviation that “we should put a boot on the neck of BP.” Paul said that such rhetoric is un-American, not holding BP accountable for damage it has caused.

In other words, Paul was replying to a specific statement in which a Democrat was wanting the government to go further than the law allows in going after BP. He never said BP should not be criticized, nor did he say criticism was "un-American."

Now, it is one thing when Tim Kaine says something like what he said to Chris Wallace. He is a politician and I expect exaggerations and pure partisan rhetoric from the man.

It is quite another, however, when a Nobel Prize winner acts clearly in concert with politicians to put out statements that either are inaccurate or absolutely untrue. This is behavior that should be beneath someone of his stature, but apparently we now are in an age when we have come to expect a highly-decorated academic to make statements that patently are lies at worst and mis-statements at best.

I cannot recall seeing any other Nobel Prize winner in economics engage in this kind of dishonest partisan behavior, not on the right nor the left. Apparently, Krugman is in a class by himself.

Saturday, May 22, 2010

Paul Krugman, as a New York Times columnist, is supposed to operate independently of the newspaper's editorial policy, in that his columns are supposed to reflect his thinking and not be done in coordination with the newspaper's editorials. Of course, his latest attack on Rand Paul and the appearance of the paper's editorial calling Paul a racist just might be coincidence, but I have my doubts.

Why is Rand Paul a "racist," according to Krugman and his employer? He is a racist because he does not believe that the federal government should dictate anti-discrimination policies to private businesses via the Civil Rights Act of 1964. Keep in mind that Paul has not used racially-inflammatory language during his campaign or even brought up race at all. However, if he does not worship at the feet of the feds, then he is by definition a racist, or at least that is what they claim at the NYT.

Writes Krugman:

You know, if Rand Paul loses his Senate race, in a way I’ll be sorry. He’s been so much fun in such a short period of time!

Anyway, given the flap over his assertion that he wouldn’t support the Civil Rights Act of 1964, some Republicans are making the argument that they were the party of civil rights, while Democrats were the enemies. And there’s some truth to that: in the 1950s and early 1960s, the opponents of civil right were largely Southern Democrats.

But what happened to those Southern Democrats? They became Republicans. And I’m not just speaking metaphorically: many Republican members of Congress during the era of GOP dominance were, literally, former Democrats who switched parties.

The point is that today’s Democratic party is, effectively, the party of Lyndon Johnson, whose decision to push forward on civil rights cost the party the South, as he knew it would. Meanwhile, today’s Republican party is the party of Richard Nixon, who cynically exploited the backlash against civil rights to build a new majority.

Therefore, Rand Paul is a "Southern Democrat" who is a racist, like Theo Bilbo or George Wallace in his earlier years. Now, Krugman offers no proof that Paul is a racist; he just makes the connection.

Likewise, his employer declares:

In a handful of remarkably candid interviews since winning Kentucky’s Republican Senate primary this week, Mr. Paul made it clear that he does not understand the nature of racial progress in this country.

As a longtime libertarian, he espouses the view that personal freedom should supersede all government intervention. Neighborhood associations should be allowed to discriminate on the basis of race, he has written, and private businesses ought to be able to refuse service to anyone they wish. Under this philosophy, the punishment for a lunch counter that refuses to seat black customers would be public shunning, not a court order.

It is a theory of liberty with roots in America’s creation, but the succeeding centuries have shown how ineffective it was in promoting a civil society. The freedom of a few people to discriminate meant generations of less freedom for large groups of others.

It was only government power that ended slavery and abolished Jim Crow, neither of which would have been eliminated by a purely free market. It was government that rescued the economy from the Depression and promoted safety and equality in the workplace. (Emphasis mine)

Republicans in Washington have breathlessly distanced themselves from Mr. Paul’s remarks, afraid that voters might tar them with the same extremist brush. But as they continue to fight the new health care law and oppose greater financial regulation, claiming the federal government is overstepping its bounds, they should notice that the distance is closing.

Now, the editors don't explain how the government "rescued" the economy from the Great Depression, given that the rate of unemployment in 1939 was substantially higher than it was in 1930 or even 1931, and was close to the 1933 high of 25 percent. However, we are speaking of the NYT, the same newspaper that tried to claim that Duke lacrosse player Reade Seligmann simultaneously could be both at a bank teller and at a party miles away raping Crystal Mangum. This is a newspaper that believes its very words supercede reality.

Krugman makes one more interesting comment: "So yes, let’s honor the great Republicans of yore; I’m a Lincoln man, myself."

That is interesting. Lincoln was a self-proclaimed racist, whose Illinois did not permit free black people to live within its state borders. Lincoln also ordered his armies to loot, burn down whole cities and towns, and whose armies went pillaging and raping as they went along.

Thus, if I am to follow Krugman's logic (and the logic of his employer), then Krugman favors rape, racism, and destruction. Hey, if he is a "Lincoln man," then he has to favor what Lincoln did.

Friday, May 21, 2010

There are two reasons why I believe Keynesian economic analysis is popular not only in academe but also in government circles. The first is obvious: any kind of analysis that claims only government can create prosperity is going to be the ideology of choice by those in government, and those who believe that they should be empowered to tell others what to do.

The second reason is that Keynesian analysis is pretty easy to understand and to teach. (I always wait until the end of the semester to teach the "aggregate demand -- aggregate supply lessons, but students have no problem understanding how the graphs work and the Keynesian claims.) According to the Keynesians, the entire economy is moved by aggregate spending on consumption goods and services. There is no concern at all about the factors of production, no messy "structure of production" to analyze, nor should one worry about inflation, as inflation is good for the economy. Just spend, spend, spend, and everything is fine.

Thus, Krugman's column today in which he foresees a "lost decade" for the United States, does not surprise me. His prediction might be true, but perhaps it is ironic that Krugman's very policy prescriptions that the government is following will be the reason for that "lost decade."

First, he writes:

Recent data don’t suggest that America is heading for a Greece-style collapse of investor confidence. Instead, they suggest that we may be heading for a Japan-style lost decade, trapped in a prolonged era of high unemployment and slow growth.

Let’s talk first about those interest rates. On several occasions over the past year, we’ve been told, after some modest rise in rates, that the bond vigilantes had arrived, that America had better slash its deficit right away or else. Each time, rates soon slid back down. Most recently, in March, there was much ado about the interest rate on U.S. 10-year bonds, which had risen from 3.6 percent to almost 4 percent. “Debt fears send rates up” was the headline at The Wall Street Journal, although there wasn’t actually any evidence that debt fears were responsible.

Since then, however, rates have retraced that rise and then some. As of Thursday, the 10-year rate was below 3.3 percent. I wish I could say that falling interest rates reflect a surge of optimism about U.S. federal finances. What they actually reflect, however, is a surge of pessimism about the prospects for economic recovery, pessimism that has sent investors fleeing out of anything that looks risky — hence, the plunge in the stock market — into the perceived safety of U.S. government debt.

What’s behind this new pessimism? It partly reflects the troubles in Europe, which have less to do with government debt than you’ve heard; the real problem is that by creating the euro, Europe’s leaders imposed a single currency on economies that weren’t ready for such a move. But there are also warning signs at home, most recently Wednesday’s report on consumer prices, which showed a key measure of inflation falling below 1 percent, bringing it to a 44-year low.

This isn’t really surprising: you expect inflation to fall in the face of mass unemployment and excess capacity. But it is nonetheless really bad news. Low inflation, or worse yet deflation, tends to perpetuate an economic slump, because it encourages people to hoard cash rather than spend, which keeps the economy depressed, which leads to more deflation. That vicious circle isn’t hypothetical: just ask the Japanese, who entered a deflationary trap in the 1990s and, despite occasional episodes of growth, still can’t get out. And it could happen here.

So what we should really be asking right now isn’t whether we’re about to turn into Greece. We should, instead, be asking what we’re doing to avoid turning Japanese. And the answer is, nothing.

It’s not that nobody understands the risk. I strongly suspect that some officials at the Fed see the Japan parallels all too clearly and wish they could do more to support the economy. But in practice it’s all they can do to contain the tightening impulses of their colleagues, who (like central bankers in the 1930s) remain desperately afraid of inflation despite the absence of any evidence of rising prices. I also suspect that Obama administration economists would very much like to see another stimulus plan. But they know that such a plan would have no chance of getting through a Congress that has been spooked by the deficit hawks.

In short, fear of imaginary threats has prevented any effective response to the real danger facing our economy.

Will the worst happen? Not necessarily. Maybe the economic measures already taken will end up doing the trick, jump-starting a self-sustaining recovery. Certainly, that’s what we’re all hoping. But hope is not a plan.

In other words, the problem is that we don't have enough inflation. However, there is something that Krugman misses, and that is the fact that there are massive malinvestments in our economy that the government continues to try to prop up. Furthermore, the government is forcing billions of dollars to be spent on resources that cannot be sustained in our economy without draining the healthy industries. That is the meaning of "malinvestments."

Is there an alternative view? Doug French, in a recent article, points out that the Japanese economy in the late 1980s had a both real estate and stock market bubbles (Sound familiar?) and the government did exactly what Krugman has said needs to be done. French writes:

After the bubble popped in Japan, that government pursued a relentless Keynesian course of fiscal pump priming and loose fiscal policy with the result being a Japan that went from having the healthiest fiscal position of any OECD country in 1990 to annual deficits of 6 to 7 percent of GDP and a gross public debt that is now 227 percent of GDP. "The Japanese tried to cure an alcoholic with heroin," writes Bonner. "Now, they're addicted to it."

Japan's monetary policy was to aggressively lower rates to .5 percent between 1991 and 1995 and has operated a zero-interest policy virtually ever since.

Between 1992 and 1995, the Japanese government tried six stimulus plans totaling 65.5 trillion yen and they even cut tax rates in 1994. They tried cutting taxes again in 1998, but government spending was never cut. Also in 1998, another stimulus package of 16.7 trillion yen was rolled out nearly half of which was for public-works projects. Later in the same year, another stimulus package was announced, totaling 23.9 trillion yen. The very next year an ¥18 trillion stimulus was tried, and, in October of 2000, another stimulus for 11 trillion was announced. As economist Ben Powell points out, "Overall during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession," with Japan's nominal GDP growth rate below zero for most of the five years after 1997.

The simply question, then, is this: Why didn't this "stimulus" work in Japan and why won't it work here? The answer can be given in one word: malinvestments.

In the Keynesian world, all assets are homogeneous, and all that needs to be done is to stimulate consumer spending. If consumers spend, then the factors of production automatically adjust and the economy is fine. However, Austrians point out that the real activity is in the factors themselves, and when government "stimulus" programs encourage people to spend now, their spending patterns will change the very structures of production.

The recessions begin when the production structures develop problems, which then leads to less spending by consumers. In other words, Keynesians get it backwards. They believe that the recessions begins with a fall in consumer spending when then moves to the production side.

In other words, the gulf between Keynesians and Austrians is huge and cannot be bridged. That people in power are listening to Krugman and the Keynesians means that we are in for a long, harsh, and ruinous recession. Unfortunately, the government and its allies will blame private enterprise, and the Congress will pass news laws that will make us even poorer. Like it or not, that is our future.

Tuesday, May 18, 2010

In a recent blog post, Paul Krugman makes what I believe to be an insightful comment on the flexibility of labor markets, and there is no reason to disagree with him as far as the statement goes. The disagreement, of course, is about what to do regarding this situation.

He writes:

Perhaps the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue — the elephant in the euro. With a unified currency, adjustment to differential shocks requires adjustments in relative wages — and because the nations of the European periphery have gone from boom to bust, their adjustment must be downward. At this point, wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany. Let me repeat that:

WAGES IN THE PERIPHERY NEED TO FALL 20-30 PERCENT RELATIVE TO GERMANY.

For many years, government employee unions in countries like Greece and Spain have been able to extract attractive pay packages and because the employees were being paid in euros, they found themselves enjoying a very high standard of living. However, this is not because they were earning such a standard, but rather because they had the political power to extract such standards from other people who were poorer -- and who had to do real productive work.

Unfortunately, Krugman, as a True-Believing Keynesian, does not see this relationship at work. Instead, he relies on the Keynesian belief -- based upon what I believe are accurate empirical observations -- that labor markets are less-flexible than markets for commodities. He notes:

How hard will it be to achieve this? Look at Latvia, which has pursued incredibly draconian austerity. Unemployment has risen from 6 percent before the crisis to 22.3 percent now — and wages are, indeed, falling. But even in Latvia labor costs have fallen only 5.4 percent from their peak; so it will take years of suffering to restore competitiveness.

The official answer is that this just shows the need for more flexible labor markets. But this was a subject we all batted back and forth in the initial debate about the euro, circa 1990: nobody has labor markets that flexible. If the euro isn’t workable without highly flexible nominal wages, well, it isn’t workable. (Emphasis his)

Thus, the Keynesian "solution" to this problem: inflation. In The General Theory, Keynes recognized the problem of labor costs being out-of-kilter and the difficulty in bringing them back into line, with the result being that labor would be priced out of the market and would result in high rates of unemployment.

I don't think anyone disagrees with that point, for it is pure classical economic theory at work. However, Keynes' "solution" was for government to give workers a wage cut through inflation, and he wrote that since he believed that workers only were concerned about their nominal (not real) wages, this "trick" would work time and again.

Indeed, since Krugman says that letting wages adjust by falling is not "workable," then he has the solution: inflation. Where Keynesians and Austrians differ, however, is that Keynesians see labor and factor markets as being somewhat homogeneous, while Austrians recognize that there are imbalances in these markets that are made worse by inflation. In the Austrian view, inflation is not a "solution" at all; it only exacerbates the problem, creating more malinvestments and leading to future crises.

Monday, May 17, 2010

One of the more seamy characteristics of Paul Krugman's columns has been his hyper-partisan pronouncements, which is something I never have seen from a "conservative" economist on the other side. For example, Don Boudreaux of George Mason University, is well-known for his public pronouncements, and he definitely falls into the "I Like Markets" category of academic economists, yet I never have seen him outright shill for the Republican Party in the way that Krugman shills for the Democrats.

Thus, we see more of the same today, as Krugman claims that the move by some Republicans to want abolition of the Federal Reserve System or are angry about the bailouts is nothing more than unwarranted, insane extremism. He writes:

Utah Republicans have denied Robert Bennett, a very conservative three-term senator, a place on the ballot, because he’s not conservative enough. In Maine, party activists have pushed through a platform calling for, among other things, abolishing both the Federal Reserve and the Department of Education.

To be specific, Bennett lost his spot on the Republican ballot in Utah because he voted for the bailouts and he voted to expand the federal government's role in medical care. These are not trivial things, to put it mildly. The bailouts were aimed at propping up a reckless financial culture complete with out-of-kilter bonuses for CEOs and the government's newest excursion into medical care is going to mean less care at higher real costs.

The notion that our entire economy would have collapsed had Congress and the Bush administration not pushed through the bailouts is false. In fact, if there was "extremism," it was in taking resources from productive people and giving those resources to people who were wasting money. The bailouts, both the Wall Street kind, and the GM/Chrysler giveaways, were much more extreme than anything that the Maine or Utah Republicans have wanted to see.

However, I need to concentrate now on the subject of the title, the abolition of the Federal Reserve System. First, I need to point out that the Fed was not even in existence until 1914, when it opened for business. From the end of the American Revolution until the eve of World War I, the U.S. economy grew at astounding rates, yet there was no "Fed" to backstop the losses from banks.

It is true that there were "panics," as commercial, fractional-reserve banks became over-extended, but each time, the economy corrected itself and prosperity returned quickly. Compare that record to the 1930s, when the U.S. economy suffered double-digit unemployment for a decade.

Unfortunately, Krugman literally considers anyone who believes that a central bank is harmful to an economy as a "nut job" or an "extremist," and I would say that his statements demonstrate a "religious" faith in the Fed that simply do not reflect the real record of this entity. Krugman, who subscribes to Keynesianism the way that an Imam subscribes to Islam, does not offer any reason as to why having religious belief in the Fed is good, but seeking its abolition is dangerous extremism.

For Keynesians, the key to economic success is the government's "ability" to create new "money" through the printing press. If government prints money, then an economy will have "adequate purchasing power" to keep the engine running. (Granted, Krugman realizes that if an economy does not have a "hard" currency, then the Zimbabwe experience of hyperinflation may be the result. However, Krugman does not explain why it is that the U.S. Dollar cannot turn out like the Zimbabwean Dollar if the Fed continues its expansion of the stock of new money. For Krugman, the USD holds its value no matter what, which is a foolish proposition.)

Because Keynesians hold to the view that "purchasing power" (which to Krugman and others is the REAL source of wealth) comes from the government printing presses, one can see the real fear they would have if the Fed were abolished. And while I have not heard any Keynesian say why it was that the U.S. economy went along quite nicely before the establishment of this central bank, most likely they would claim something like, "Things were different then."

Uh, the laws of economics do not change over time, no matter what Keynesians and Historicists might think. The Law of Demand, the Law of Supply, and the Law of Marginal Utility exist in any situation at any time in history. (In the Book of I Kings, the Bible says that silver was so plentiful in Israel during Solomon's reign that its value shrank to next-to-nothing. That is the Law of Marginal Utility in action.)

Contra Krugman, Austrian economists do not believe that the Fed, through its massive efforts to print money and paper over huge financial losses by the banks and certain politically-favored firms like GM, has "saved" the economy. All the Fed has done has been to extend the crisis and to put off a real Day of Reckoning in the future. Like the 1970s, in which the economy lurched from inflation to unemployment time and again, we are seeing an inflation-fueled "recovery" which really is no recovery at all.

My sense is that in future columns, Krugman will try to claim that anyone who believes the Fed should be abolished is a racist and Lord-knows-what-else. I'm beginning to wonder who the real "extremist" really is.

NOTE TO READERS: I apologize for having fewer posts than I have in the past. While the jury has rendered a "not guilty" verdict in the Tonya Craft trial, there still is much work to be done on that case and in similar cases in the Lookout Mountain Judicial District of Northwest Georgia. I'm still heavily involved in that situation, which has kept me from being as diligent as I once was with this page. Thanks for your patience.

Friday, May 14, 2010

In his latest column, Paul Krugman pronounces the obvious: the political and economic situation in the USA is not what it is in Greece. Glad that he could pontificate on the obvious. The question that is relevant, however, is this: Are we headed in that direction? I believe we are.

Furthermore, Krugman seems to contradict his own Keynesianism in the following statement:

We’d be better positioned to deal with the current emergency if so much money hadn’t been squandered on tax cuts for the rich and an unfunded war. But we still entered the crisis in much better shape than the Greeks.

According to Keynesian doctrine, however, it would seem that both the tax cuts (actually, rates at all levels were cut, not just the top rates) and U.S. wars abroad would have "stimulated" the economy, especially since the economy was sluggish when both things were put into place. Furthermore, if budget deficits and government spending were bad then, how are they good now? (Yes, the Democrats are in charge, so whatever they do is good, and while I am non-partisan in my economic approach, Krugman's partisanship is not exactly appealing.)

So, why is Krugman so optimistic now, even though the lower tax rates remain (through this year) and the wars continue? In his own words:

...we have a clear path to economic recovery, while Greece doesn’t.

The U.S. economy has been growing since last summer, thanks to fiscal stimulus and expansionary policies by the Federal Reserve. I wish that growth were faster; still, it’s finally producing job gains — and it’s also showing up in revenues. Right now we’re on track to match Congressional Budget Office projections of a substantial rise in tax receipts. Put those projections together with the Obama administration’s policies, and they imply a sharp fall in the budget deficit over the next few years.

This does not compute if the Bush policies of, well, "fiscal stimulus and expansionary policies by the Federal Reserve," led us into recession. In other words, Krugman has no real causality theory as to why we got into recession in the first place.

Now, Krugman will tell you that the reason things got this was that the government did not effectively regulate the financial markets, which jumped into the housing bubble feet-first. Yet, he ignores the fact that the Fed was pumping money into the system, directing it to housing, and that whole issue of home ownership itself has been pushed by the federal government for more than 70 years, which has meant all sorts of programs aimed at putting people into home ownership that, to be frank, should not be buying houses.

In fact, he has claimed elsewhere that the Fed should be holding down interest rates while the government, at the same time, should make sure that it effectively determines the "safe" havens for the new money. Furthermore, Krugman forever confuses cause with effect by claiming that the recession occurred because people stopped spending, as opposed to the Austrian view that people slowed down their spending precisely because the economy moved into recession.

As for the current "recovery," Krugman still sticks to the false belief that the Fed can print us out of the downturn, and as for claiming our future will not mirror that of Greece simply because this government "controls" its own currency, he needs to get an education. Why? Much of the reason that Greece is not able to make the necessary adjustments is that government spending accounts for a much larger percentage of GDP than our own.

Moreover, the public employee unions in Greece are extremely militant, and they will fight any cuts in government spending. And what does Krugman recommend here? He believes that we need more unionization to push for higher wages (which, in his view, "stimulate" spending) and an expansion of the reach of government.

So, let me get this straight. Greece is worse off than the USA, but the way that we can improve our economy is to be more like Greece -- except for one thing. Greece cannot inflate its currency, given it is on the euro, but the United States Government can print unlimited amounts of dollars, which the ancients once called inflation.

Tuesday, May 11, 2010

With the latest bailout package now aimed at the crisis with the "PIGS," we need to step back and ask just what has been done, for it is not what it seems. Unfortunately, we have seen the cheers from the Usual Suspects, beginning with the New York Times, which declared in an editorial:

Europe’s leaders stared into the abyss and finally decided to act. The nearly $1 trillion bailout package, arranged over the weekend, is intended to head off Greece’s default and stop the crisis from dragging under other weak economies — Portugal, Spain, Ireland and Italy are all vulnerable.

The European and American markets celebrated on Monday. The CAC-40 index in Paris rose almost 10 percent. The Dow Jones industrial average rose 3.9 percent. It was certainly the right thing to do. Coupled with the European Central Bank’s promise to buy bonds from stricken European countries, it arrested the financial turmoil — at least for now.

The last sentence is unintentionally prophetic, for whatever “good effects” the announced bailout supposedly will create, they will be short and are paving the way for future crises. While Greece and other European countries were facing disaster at the present time, it is nothing like the disaster that looms because there still is an economic piper to pay.

To make matters worse, the U.S. Government and especially President Obama urged this package under the "try something big" approach, as opposed to the advice of "try something intelligent." Yet, that is what we are going to get: stupid policies that ultimately will undermine any hope of recovery.

First, and most important, the European Central Bank is not buying bonds with real money, just the printed stuff that will filter throughout Europe and elsewhere and devalue the accounts of anyone who is holding Euros. Like the United States, Europe is broke, and will be even more so once this “bailout” goes through.

Second, for all of the talk of “rescuing” Greece, Spain and Portugal, one asks: Rescued from what? It is easy to diagnose the sources of their difficulties: a bloated public sector complete with militant public employee unions and workplace rules that raise private employment costs to such ruinous levels that all three countries must deal with high unemployment. The “rescue” packages supposedly deal with the former (although I remain a skeptic that they will), yet the real problem lies with the latter, as government policies shackle private investment.

A more expansionary monetary policy could make a real difference — especially if the ECB ends up accepting somewhat higher inflation. Suppose that Speece or Grain need to get relative prices down 15 percent over the next five years. If the eurozone has 1 percent inflation, that’s 10 percent deflation in the periphery. If the eurozone has 3 percent inflation, all you need is stable prices. Also, a stronger overall eurozone economy means higher GDP and hence higher revenue, making the fiscal slog less grim. (Emphasis mine)

There he goes again. Keynesians believe that as long as people are spending (and spending and spending), an economy automatically moves along and all is well. Austrians, however, understand that while things might seem fine on the surface, there is turmoil and distortion among the factors of productions. Although Keynesians believe that the factors are homogeneous and that factor prices always adjust evenly to consumer spending, that simply is not the case.

Economic downturns do not occur because people stop spending, as Keynesians believe. Instead, people stop spending because the economy moves into recession, and stuffing more paper money into the hands of people so they can continue to spend only makes matters worse. Why? Because the recessions are centered on malinvestments which no longer can be supported by consumer spending patterns, the factors associated with those malinvestments also must be liquidated or transferred to other uses in order to allow a real economic recovery to begin.

Bailouts do not just prevent that process, but they also encourage malinvestments to continue, furthering the patterns of distortion and making them worse. At some time, the further rounds of inflation no longer can paper over the distortions and the resulting economic collapse is much worse than it should have been. Thus, instead of “saving” Europe, the central bankers only have put off the Day of Reckoning, which surely will arrive at a future date.

Monday, May 10, 2010

When the U.S. economy moved into recession about the time of President George W. Bush's inauguration, Paul Krugman was quick to blame the downturn on Bush and his proposed tax cuts. Indeed, it would be months before Congress approved the Bush-proposed legislation that cut the top rates from 39.6 percent to 33 percent, which is not a huge cut, but STILL Krugman tried to claim that even the very THOUGHT of such a tax cut was enough to send the economy spiraling downward.

Later, Krugman would blame the financial meltdown on a lack of regulation, as though everyone in the SEC was a financial genius who ALWAYS knew what would be the perfect and riskless investment, IF ONLY they would be permitted to "regulate properly." (That the Clinton administration presided over a huge bubble in the stock markets, calling it "the New Economy," did not earn the same denunciation, which is not surprising, given my previous post about Krugman's outright hyper-partisanship.)

In fact, Krugman once again brings up Hurricane Katrina, giving us the same line that the FEMA of the Clinton years miraculously would have saved everyone in New Orleans and had the perfect response to the aftermath of the hurricane. The well-known libertarian writer (and ferocious critic of the Bush gang) James Bovard, in his book on the Clinton years, Feeling Your Pain, has a chapter on FEMA that is worth reading if the readers are tempted to think that FEMA was anything but a vote-buying joke.

As for the oil spill, I find it interesting that more than a year into the Obama administration, anything bad that happens still is Bush's fault. However, as I noted earlier, as soon as Bush took office, he was responsible for an economy diving into recession.

One can find plenty not to like about George W. Bush, and I never voted for the guy, never supported him, and was glad to see him gone. To be frank, economists should not like any modern president's policies, given that presidents are likely to burden the economy with rules and regulations and patronage that force people to spend trillions of dollars on things that make it much more difficult for entrepreneurs to find profitable opportunities.

However, once again, we find Krugman playing the partisan role, just as he has done before. I would expect more from a Nobel Prize winner, but, then again, it is Krugman of which I speak. Enough said.

Sunday, May 9, 2010

The latest issue of Econ Journal Watch has an article by Brett Barkley on how economists change their interpretation of economic events when a person of their own party takes over the White House. Barkley looked at 17 economists, and while 11 were consistent, and five changed their outlooks somewhat, on economist changed his viewpoints in a significant way: Paul Krugman.

Somehow, I am not surprised, as Krugman has been a loud partisan voice instead of a voice of reason. His commentary on the latest jobs report from the government provides another example of partisanship. He writes:

An actually good employment report. A reminder: there are two separate surveys, one of employers — which is where the 290,000 jobs number comes from — and one of households, which is where the 9.9 percent unemployment rate comes from. Sampling error, seasonal adjustments, and other technical factors can make these reports give contradictory indications.

Unfortunately, as he later adds, the economy won't be adding jobs as quickly as it did during the Clinton years. However, he fails to put two and two together.

In the past few years, the federal government has gone on a spending spree, starting with the unwise bailouts and Federal Reserve System initiatives when it became clear the economy was moving into crisis mode. We have high unemployment not (as Krugman says) because the "stimulus" was not "bold enough," but rather because the government continues to print money in order to prop up weak sectors.

If Krugman wonders why we are looking at high unemployment for the next generation, he might want to look in a mirror, for the high-deficit policies of borrowing and spending have been disastrous.

Friday, May 7, 2010

I am thankful for Paul Krugman, if for no other reason he has helped me keep my thinking diversified even as the Tonya Craft sham of a trial goes on and takes most of my attention. As the "Greek tragedy" unfolds and Krugman makes his commentaries, once again we see the difference between the Keynesian approaches and the Austrian ones.

The problem, as obvious in prospect as it is now, is that Europe lacks some of the key attributes of a successful currency area. Above all, it lacks a central government.

Now, how would a strong central government be able to rescue Greece from its current crisis? Krugman explains:

First, Greek workers could redeem themselves through suffering, accepting large wage cuts that make Greece competitive enough to add jobs again. Second, the European Central Bank could engage in much more expansionary policy, among other things buying lots of government debt, and accepting — indeed welcoming — the resulting inflation (emphasis mine); this would make adjustment in Greece and other troubled euro-zone nations much easier. Or third, Berlin could become to Athens what Washington is to Sacramento — that is, fiscally stronger European governments could offer their weaker neighbors enough aid to make the crisis bearable.

So, the idea would be for all of Europe to have more inflation via action from the central bank, and thus all of the Europeans could damage their economies simultaneously, creating new crises that Krugman conveniently fails to mention. (Inflation has a way of doing that.)

But, Krugman is not finished, as he also lays out another scenario: Greece leaves the Euro and goes back to the Drachma. In his own words:

If it happens, it will play something like Argentina in 2001, which had a supposedly permanent, unbreakable peg to the dollar. Ending that peg was considered unthinkable for the same reasons leaving the euro seems impossible: even suggesting the possibility would risk crippling bank runs. But the bank runs happened anyway, and the Argentine government imposed emergency restrictions on withdrawals. This left the door open for devaluation, and Argentina eventually walked through that door.

If something like that happens in Greece, it will send shock waves through Europe, possibly triggering crises in other countries. But unless European leaders are able and willing to act far more boldly than anything we’ve seen so far, that’s where this is heading.

Here is the problem that Krugman forgets: if Greece leaves the Euro, its currency will be considered "soft" on the world markets, like the currencies of Third World nations or of the old communist bloc. Combined with the big increase in inflation as Greece tries to print its way out of the crisis will be the fact that the Greeks will find the costs of imported goods skyrocketing, and they will be reduced quickly to poverty.

Krugman does not understand that deflation and recession would be the BEST things to happen to Greece, as while there might be default, the Greeks once again would be able to get their fiscal house in order. Yes, there would be a quick drop in their standard of living, but they not only would get past that quickly as the economy recovers, but they also would have a brighter future.

The Krugman "solution," however, only extends the problem into the healthier economies of Europe and with inflation, the "good" effects come first, and the "bad" effects are felt later. With deflation, it is the other way around. The Greeks will have troubles up front, but things will get better.

What Krugman does not understand is that the inflation "solution" only will distort the Greek economy even more without solving ANY of the underlying problems. Look, the Greeks are headed for very rough times no matter what they do. However, it would make sense for them at least to be able be doing something that would give them a decent economic future.

Thursday, May 6, 2010

The old saying, "Beware of Greeks bearing gifts," might now be changed to, "Beware of Greeks bearing debt." Indeed, after yesterday's murderous riots, people also need to beware of Greeks bearing Molotov Cocktails, as Greek government employees, after living high on financial bubbles, do not believe they should have to face financial reality.

In a blog post, Paul Krugman acknowledges that the "Greek end game" is going to be disastrous no matter what, as no one there is willing to face the truth: Greece was living in a bubble economy, and when the bubble bursts, there is nowhere to hide. Unfortunately, as a true Keynesian, Krugman believes that the Very Worst Thing that can happen Greece is deflation.

But even Krugman admits that the Greeks need to get their economy into some kind of balance, and that is amazing, given that Keynesians believe that all factors of production, for purpose of economic analysis, are homogeneous, and the way to get costs of factors (especially labor) and prices of goods into "balance" is through inflation. Yet, even that bit of wisdom is tempered with Keynesian foolishness. He writes:

The only thing that could reduce that need for austerity would be something that helped the economy expand, or at least not contract as much. This would reduce the economic pain; it would also increase revenues, reducing the needed amount of fiscal austerity.

But the only route to economic expansion is higher exports — which can only be achieved if Greek costs and prices fall sharply relative to the rest of Europe.

He admits, however, that Greece is not a cohesive society, so the most likely scenario is for Greece to "leave the Euro" and go to printing Drachmas again. That, Krugman admits, will be disastrous, triggering bank runs and worse.

Yet, Krugman does not realize that the problem of leaving the Euro would create even more problems for Greece than bank runs. Should Greece leave the Euro and go back to the Drachma, the currency markets will treat the Drachma as "soft money" and give it the same status as money from Zimbabwe, which does not trade on any currency markets.

To put it another way, Greece will become essentially a Third World country. How did this happen? It happened because central banks around the world engaged in Keynesian "expansion" by creating Dollars, Euros, you name it. Keynesians believe that such action can go on forever without creating any consequences. As you can see, that simply is not true.

Greece is living the consequences. They either can get their house in order and suffer the short-term consequences, or they can go on living in the inflationist fantasy that is Keynesian "economics."

Tuesday, May 4, 2010

Keynesian economists believe that much of what drives private investment in the economy falls into the "animal spirits" category, and those "spirits" make for volatile investing habits. (You have to remember that Keynesians see "investment" as being useful only in that investors are "spending." That we have capital formation really means nothing to the average Keynesian, as he or she believes that production is a rather meaningless and detached part of the economy, and that enough "spending" will magically create the goods that will be demanded.)

From a short-term economic point of view, this may be a self-fulfilling prophecy, as optimism raises consumer spending.

Will it have political implications? Is economic optimism arriving just in time to save Democrats from a midterm disaster?

From where does consumer spending come? In Krugman's world, consumers just start spending, and out of that comes the recovering economy. In reality, it does not work that way.

This week, I will be covering Say's Law in my principles of macroeconomic classes, which would be anathema to Krugman. Say demonstrated in his 1803 book on political economy that all of our "spending" must have a source: our production.

It makes sense. Economies that produce a lot of goods that people want also are economies with lots of consumer spending. Think about it; all of use work to produce a good or service that others want, and by being paid with money, we then can find a way to "trade" what we have produced so that we can gain goods and services that others have made.

Krugman and Keynesians, on the other hand, see no meaningful connection between production and consumption, and this dichotomy not only is central to Keynesianism, but also to Marxism, socialism, and Institutionalism (of the old variety as developed by Thorstein Veblen more than a century ago). To a Keynesian, we produce goods and then hope that the producers have enough money and the will to spend so they can "buy back the product" they created when they become consumers.

Sometimes, this really becomes ridiculous, as shown by this example. Around 1908, Henry Ford doubled the pay of the workers at his Dearborn, Michigan, plant from $2.50 a day to $5. According to the Keynesians and others, by doing so, Ford "turned his workers into consumers and created the American middle class."

Why is this notion ridiculous? Think about it. If all Ford did was to double the pay of his workers, doing so would have doubled his labor costs, which would have meant that in order to make a profit, he would have to sell his cars at much higher prices than he already was doing.

However, we know that Ford cut the price of the Model T to under $300 after a while, which fulfilled his goal of making the automobile available to nearly anyone. So, this notion that he raised wages to give his workers more money so they could "buy back" the cars they made simply makes no sense. None.

What happened was this: the assembly-line work was monotonous, and Ford had huge, costly turnover problems. By doubling wages, which then were the highest industrial wages in the world, he solved the turnover issue and those cost savings more than made up for the higher labor costs. Furthermore, by ensuring that his workers would be available and anxious to keep their high-paying jobs, Ford could turn his attention to the quality issues that had been plaguing the production of the Model T.

In the end, Ford said that what he did was a "cost-saving" measure, as he took into consideration ALL of his opportunity costs of production, not just the simple wages. Now, most people can understand this explanation, but because Keynesians are so stuck on the "buy back the product" mentality, this bit of logic escapes them.

As for our current "recovery," I am sorry, but there is no meaningful recovery out there. The Obama administration is forcing up business costs, but does nothing to encourage new investments in those product lines that can lead us out of the recession.

Instead, the administration touts its heavily-subsidized "green energy" nonsense that literally destroys wealth in the name of creating it. Yes, "green energy" will "create jobs" in some subsidized industries, but it does so ONLY by damaging the healthy, profitable firms and putting those workers out of jobs.

Krugman, unfortunately, is so partisan that he actually can praise this "recovery" only because Obama, a Democrat, is president. Would he be saying the same thing about this "recovery" if a Republican were in charge? I doubt it.

No, I have no desire to shill for the Republicans, but nonetheless I would like to see an economist be something other than a political operative.

Monday, May 3, 2010

While Paul Krugman now has switched to promoting environmentalism again (and the fraud of "green energy"), I want to deal today with another problem that he and his friends have helped cause: teenage unemployment rates.

Mayors across the country are rightly worried about Congress’s failure to provide money for the summer jobs that keep teenagers off the streets while giving them sorely needed work experience. Unless the Senate acts quickly, this will be one the bleakest summers on record for youth employment. That raises the very real danger that it could be a violent summer as well.

Furthermore, the NYT even sees the "solution," which at best could be described as a "workfare" program:

The House has approved $600 million for summer jobs for teenagers. The Senate has failed to act. Senate Republicans have blocked a separate proposal by Patty Murray, Democrat of Washington, that would have committed $1.3 billion to create 500,000 summer jobs for the young.

I did the math, and found that such a program (which I doubt seriously actually would employ that many people) would cost $3,000 per job. To people like Krugman and his employer, that might be called an "investment," but to an economist who sees labor as a factor of production, it is called a cost.

There is a dual problem here that goes to the heart both of economic theory AND economic policies, and that problem is that Keynesians like Krugman and True Wooly-Headed Liberals as populate the NYT editorial board (and newsroom) believe that production and consumption are separate and unequal entities. In this viewpoint, the end of production is not necessarily consumption; instead, consumption is what is needed to clear inventories so people can produce more goods and, thus, stay employed.

For example, when Hillary Clinton went to China last year, she essentially told the Chinese that they have to continue to purchase U.S. Government debt so that Americans could use that debt to buy more Chinese goods which, in turn, would "give" Chinese workers their jobs. This viewpoint essentially is the Keynesian position as well.

To these people, all jobs are "welfare" programs at heart, as there is no real connection between production and consumption, and that is a destructive doctrine, for it undermines the ability of people to produce those things which help fulfill our needs. Let me explain.

In a free-market economy, exchange is a voluntary act in which all parties engage because they believe that all will be better off after the exchange takes place. This may not always be the case, as people might be engaging in exchange because of faulty information, but nonetheless, we do trade with one another to improve our own welfare, and that improvement in our welfare is wealth-creating.

In fact, production itself is an act of exchange. When a person works in a free-market setting, that individual generally is creating more wealth than he or she will consume from that act of production. To put it another way, it adds a "surplus" to the economy. Marx believed that "surplus" was "captured" by the capitalists, who did not deserve it.

However, we find that in a free market, that "surplus" adds to overall wealth which then results in more and more goods and services being made available to people who previously would not have been able to afford them. The competition to make better goods also means that over time, the quality of the products should improve. (The computer industry is a prime example here.)

Thus, it is crucial that when one is employed, that the worker is able to be paid according to his or her marginal productivity, or, to use economist-speak, the discounted marginal value product (DMVP). When minimum or "living" wage policies force up wages, the laws of economics still are not repealed (no matter what politicians or the NYT might tell us).

If the law forces up wages past the DMVP, then what happens is that it costs the employers more to have the lower-productivity workers on the job than they can produce. In that situation, the workers lose their jobs.

Even Keynes recognized that fact, but his "solution" (which Krugman accepts) was to employ inflation as a means for cutting wages. (Read Keyne's own words in the General Theory in which he says that workers won't recognize that their real wages are being cut by inflation.)

There is another false argument that Krugman gives, in which he argues that raising the marginal wage would result in greater consumption and, conversely, allowing the marginal wage to fall to where it equals the DMVP would result in MORE unemployment. In his own words:

So let me repeat a point I made a number of times back when the usual suspects were declaring that FDR prolonged the Depression by raising wages: the belief that lower wages would raise overall employment rests on a fallacy of composition. In reality, reducing wages would at best do nothing for employment; more likely it would actually be contractionary.

Here’s how the fallacy works: if some subset of the work force accepts lower wages, it can gain jobs. If workers in the widget industry take a pay cut, this will lead to lower prices of widgets relative to other things, so people will buy more widgets, hence more employment.

But if everyone takes a pay cut, that logic no longer applies. The only way a general cut in wages can increase employment is if it leads people to buy more across the board. And why should it do that?

What is the problem? Krugman confuses marginal with total. Furthermore, he cannot conceive of wages being anything but arbitrary amounts of money being given to people in hopes that they will spend and keep the perpetual motion machine known as the Keynesian economy running.

Thus, because he misunderstands employment at the very fundamental level, Krugman cannot get the rest of the equation correct, either. What Krugman does not understand is that the minimum wage, while not only helping to create record unemployment rates among teenagers, also further distorts the structure of production of an economy and makes things worse over the long run.

True, Keynesians argue that "in the long run, we all are dead," but their policies are helping to put our economy in the grave.

About Me

I teach economics at Frostburg State University in Frostburg, Maryland. We are located on the Allegheny Plateau, and we have cool summers and tough winters.
I am the single father of five children, four of them adopted from overseas and I have two grandchildren. My family and I are members of Faith Presbyterian Church (PCA).